Spreadsheets to interpret credit risk in the U.S. $1.2 trillion private debt market

Successful private debt investment is all about having a good grasp of credit risk. Yet too often, adherence to antiquated portfolio management tools is making this task far harder than it needs to be.

Statistics speak volumes about the importance that many asset managers are now attaching to this asset class. According to Prequin, an investment data company, assets under management for private debt stood at U.S. $1.2 trillion at the end of 2021 and are expected to rise to U.S. $2.3 trillion by the end of 2027. Over the past decade, the size of the market has grown by an average of 13.5% a year.

Covid-19 has reinforced the appeal of the asset class. Whilst global equity markets plummeted by 30% at the start of 2020 before rebounding in the latter half of the year and listed markets also exhibited high levels of volatility due to index fluctuations, private debt had a rather calmer time.

This has raised an important question among investors: should private debt play a wider role in their portfolio?

Careful structuring of private debt can lead to significantly higher returns that are less prone to market swings, but investors need to understand how their investment sits with the overall credit risk profile of their portfolio.

The problem is that the go-to tool of many firms for managing fixed income investments– the ubiquitous spreadsheet–falls short in so many ways. Here are some of the key reasons why there is such a pressing need for more modern technology solutions in this rapidly growing segment of the market.

Credit risk assessment

Public bonds are typically rated by one or more established rating agencies, which provides some confidence for investors in understanding the riskiness of the bond. The same is not true for most private debt, which means that it is up to the investor or asset manager to perform the necessary due diligence.

Good credit risk assessment requires evaluating the debtor’s business model and the quality of its organization. It also necessitates a deep understanding of the role that private debt allocation is playing throughout the entire portfolio, since any risk of loss can be reduced by ensuring good diversification.

Market players that are serious about private debt need to develop specialized credit risk models that look at indicators such as the propensity to pay back, future earnings potential, and cash flow certainty. This must then be incorporated with the overall strategy of the portfolio. On top of this, the models must be able to quickly respond to changes in market conditions.

Spreadsheets as stand-alone do not have the sophistication that is required.

Speed

It seems that everyone is interested in investing in private debt these days, yet with growing doubt over the health of the world’s economy, the number of deals being done appears to be slowing down. According to Deloitte, there were 15.7% fewer private debt deals done in Europe in the third quarter of 2022 than there was a year earlier.

What this means is that competition for quality private debt investments is higher than ever, and speed is the decisive factor when it comes to matching private debt investment with the immediate needs of the overall portfolio.

Traditional spreadsheet-based tools often demand that too much time is spent on analyzing the data, rather than fully understanding the information contained within this data. The consequence? By the time the investor finds and understands the information they need, it may already be too late.

External reporting

Private debt is a relatively new asset class and many stakeholders–both investors and asset-owners–are still working on increasing their familiarity with it. Throw in the Covid-19 experience, when all asset classes started exhibiting peculiar behavior, and the level of wariness over exposure to private debt remains high.

This has resulted in greater scrutiny of private debt investments. Clients want to know that, if their money is going into private debt investments, it is going to be safe. Regulators are also taking more of an interest in the asset class. Accurate reporting of private debt investments is becoming crucial.

These reports need to go beyond the superficial level of investment and really provide a detailed breakdown of the underlying credit risk profile, cash flow projects, and propensity to pay back.

Storing all of this information in spreadsheets simply does not allow for the versatility and responsiveness that asset owners and regulators are increasingly demanding.

Scale

When it comes to private debt, many investors are still at the experimental stage. They are just getting familiar with the asset class and want to make sure that it is right for them before significantly ramping up exposure.

Given the advantages that private debt holds over other types of fixed income, there are certain to be many that want to increase their exposure. This will mean more portfolio complexity, making it ever-more important to keep proper track of the credit risk profile of private debt investments.

Once again, technology can lend a helping hand, increasing automation of routine tasks so that portfolio managers can focus on operational strategy and really understanding the investments that are being made.

Coherent Spark removes risk and error from spreadsheets by converting them to enterprise-grade code, automatically, instantly, and at-scale. Sign up for a demo now.

‍